Twelve Risky Financial Moves That Investors Should Avoid

If you have worked hard to gain your financial footing, you can imagine that losing your nest egg or watching it shrink would be a sickening and painful experience. Unless you’re trained to compete with the Wall-Street crowd, you should steer clear of risky investment vehicles and fancy financial maneuvers.

Here are some suggestions that will help you avoid financial disaster and allow you to sleep soundly as retirement approaches:

1. Don’t reinvest gains from sales of securities before paying the associated estimated tax.

When you sell a security for more than you paid for it, and the event is taxable, you should immediately set aside the portion of the gain to be paid as estimated federal and state income tax. Unwary folks who are carried away by their success sometimes reinvest the money without thinking about the possible negative tax consequences. If you lose part or all of the money in a subsequent transaction, you may end up paying tax on funds you no longer have.

2. When interest rates are low, purchase bonds or preferred stock with caution.

During the low end of the interest-rate cycle, smart investors search for ways to generate better returns. In their zeal to do so, however, they sometimes turn to the higher-yielding bond market. Purchasing long-term bonds in order to obtain a better rate of return is a constant temptation.

One problem with such investment decisions is that when the Federal Reserve Board changes its fed-funds-rate target, bond prices typically move in the opposite direction. At the lower end of the interest-rate cycle investors are unable to accurately guess when the Fed will begin to increase its target interest rate. When it does, folks holding long-term bonds will watch the principal value of those securities decrease.

The yield on long-term bonds is guaranteed only if you hold to maturity. If you are obliged to sell early and after interest rates start rising, you will lose money. Admittedly, if rates stay low and flat for an extended period, bond holders may recover in interest some or all of the losses they will incur when interest rates finally increase, but timing such entries and exits is tricky. While interest rates are low, committing a substantial amount of your assets to longer-term bonds and/or preferred stock is probably imprudent.

3. Avoid playing the options market.

Options trading is not for the faint of heart, and novice investors should not get involved in it. Seasoned veterans frequently lose money buying and selling options, but at least they understand the attendant risks.

Options allow folks to participate in the price movement of an underlying security without having to completely fund the purchase or short sale of that security. You should avoid this investment vehicle unless you have many years of trading experience under your belt.

4. Shun short-sale transactions.

Selling a security that you do not own is called “selling short” or a “short sale.” To implement a short sale, the stockbrokerage allows the short seller to borrow an equal number of shares of the security out of the broker’s inventory, and those shares are frozen until the short sale is resolved, i.e., the short seller repurchases the shares.

Investors who believe that a company’s stock price will fall use short sales, and as long as nothing too dramatic happens, they gain or lose money on the transaction and it’s over. In the event, however, that the stock price spikes upward while the short seller’s position is open, the losses can be great.

If a long buyer of stock is wrong about the viability of an investment, the worst that can happen is that the price tanks to zero. The potential loss is limited to the amount invested. For short sellers, however, no such limit exists. If the short seller is wrong and the price of the underlying issue skyrockets, the losses can be devastating.

Engaging in short selling may sound attractive, but the reality is that folks who are nearing retirement should not be involved in this risky business, unless of course, they undertake the venture with nonessential monies.

5. Stay clear of reverse-mortgage agreements.

A full explanation of reverse mortgages is beyond the scope of this article. They are far too complicated to explain adequately in a couple of paragraphs. Such arrangements erode the equity in your home, rob your progeny of the benefits of inheritance, and have the potential to fool you in myriad ways. If you must enter into a reverse mortgage, though, wait as long as possible (you can’t do it until you’re 62, but postponing it is better), and gather all the information about the transaction you can before taking this risk-ridden step. This advice is based on a basic rule of finance—YOU SHOULD NOT ENTER INTO INVESTMENT ARRANGEMENTS THAT YOU DO NOT FULLY UNDERSTAND.

6. Do not invest all of your money in a single annuity.

Annuity contracts are not covered by the FDIC, thus an annuity is only as secure as the insurance company that underwrites it. If the insuring entity falters, you may lose your money. If you want to participate in annuities, the best practice is to execute separate annuity contracts so that the failure of a single underwriter will not materially affect your retirement situation. You should not put all of your retirement money into any single investment vehicle or even into any single investment type. Committing to all stocks, all bonds, all annuities, or all mutual funds does not constitute a solid investment plan.

7. Don’t invest before doing your homework.

Often we learn about interesting investment possibilities from friends, colleagues, or news outlets, and we become aware that a stock’s price appears to be moving upward. At that point, you may be overcome by the impulse to purchase the security quickly. Remember this: YOU SHOULD ALWAYS DO YOUR OWN RESEARCH BEFORE PUTTING HARD-EARNED CASH INTO A NEW INVESTMENT.

Frequently, knee-jerk investment decisions don’t turn out well. Taking adequate time to evaluate a trade before executing it is the best advice. Sure, from time to time you’ll miss a deal, but for the most part, exercising calmness and prudence brings benefits.

8. Stay away from penny stocks.

Penny stocks are attractive because small upward price movements represent large percentage gains. Such stocks are volatile, though, and have little history on which to base a reasoned investment decision. In addition, often the number of shares outstanding is too few to provide the liquidity that is required to sell the stock in times of crisis, so in the event of a surprise, you might be unable to resolve your position as quickly as desired. If you must play penny stocks, invest only a small percentage of your assets in them, and put your serious funds into larger, better-established companies.

9. Don’t chase the news.

News chasers are shorter-term traders who watch the news about a company and trade in and out of its stock according to the winds blowing at the time. Rumors of good news may cause a stock’s price to increase until the moment the news is revealed, and then decrease for a while because the players liquidate their holdings once speculation becomes fact.

Folks who are not well-versed in these strategies should steer clear of them. Trading successfully on the news requires nimbleness and levelheadedness that most folks do not have.

10. Don’t try to time your purchases and sales.

Attempting to time the market is my personal nemesis. Effective market timing is nearly impossible, because by definition, no one knows the future. I’ve had some luck with timing, but I’m convinced that it’s just that—luck. The truth is that I’ve lost the market-timing game as often as I’ve won it. Trying to anticipate the market’s ebbs and flows is not worth the headache, or the losses. Making a solid investment plan and sticking with it is by far the best approach.

11. Resist the temptation to add to your position as the price increases.

When the price of a stock you own increases in value, desiring to purchase more of it is natural. Doing so may work well at the beginning of the stock’s price increase, but if the rise is great, the best approach is to create a strategy for selling without purchasing additional shares.

When you add shares late in a stock’s run-up cycle, any reversal of the price may drag you into overall losing territory. When things go south, the higher-priced shares in your portfolio have a disproportionate negative impact on the holding’s total value.

12. Don’t put all of your money into a single stock or stock class, including the company for which you work.

You may think you understand the company that employs you, but unless you are the CEO or CFO, chances are you don’t. Even if you do, though, putting all of your eggs into a single investment basket is unwise.

During the 1990s, many employees at Enron faithfully (and naively) invested their savings in the company and were shocked in 2001 when the news broke that something was amiss. Once the negative information was made public, selling and recouping the losses became impossible. Enron employees would have had to take immediate and drastic action that was contrary to their customary behavior in order to have significantly cut their losses.

The stock market is replete with danger for the unwary. Competing with Wall Street’s best and brightest is, in practical terms, impossible over the long term. While luck may intervene in some specific instances and render isolated positive results, the best practice is to develop your own set of rules that you plan to follow as you manage your portfolio. Hopefully, this list of things to avoid will help you formulate your own investment philosophy and learn to protect your hard-earned assets as you near retirement.

 
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4 comments… add one

  • maria kipper June 22, 2013 at 4:25 pm

    Thank you for all the articles about financial matters. They sure have helped us to avoid financial disasters and have guided us toward the mark of making smart decisions. I´m sure that your blog´s readers will keep in mind all the set of rules that you have manage to pass on to us. Thank for the good work.

    Reply edit
  • maria kipper June 22, 2013 at 4:58 pm

    Obrigada por todos os artigos com relação ao campo financeiro. Todos os seus informes foram muito bem elaborados e de muita importância a todos nós, que gostaríamos de fazer importantes decisões neste setor tão vital a vida de um ser humano. Nada é tão crucial em nossos dias do que evitar más investimentos e sermos bons investidores. Suas dicas ficarão em nossas mentes e ao alcance de quem quer que precise, por meio deste importante veículo tecnológico, a internet. Você tem sido muito erudito, prestativo, legítimo e muito genuíno em suas elaborações das regras relacionadas ao respectivo assunto – finanças.

    Reply edit
  • Doug Eikermann June 22, 2013 at 10:36 pm

    Obrigado pelos comentarios, Maria, pois eu concordo com voce em que as financas sao de suma importancia na vida da gente. Temo que a nossa geracao nao fez um bom trabalho em ensinar aos jovens poupar, investir, e nao gastar imprudentemente, e em poucos anos vamos ver uns resultados muito ruins. Os velhos nao vao poder aposentar a tempo, vao ficar nos trabalhos, e os jovens nao vao poder achar trabalhos por falta de vagas. Vamos ver um problema social enorme, e nao vai ter uma solucao facil.

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  • Pedro August 23, 2015 at 9:25 am

    Finanças sempre foi e sempre será um ponto muito importante na vida do ser humano, apesar de parecer algo tão básico de se saber para levarmos uma vida mais “suave”, a implementação dos seus conceitos, aparentemente, fica muito distante da teoria.
    Um paradoxo muito interessante.

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